Consultant and Advisor

Through a combination of bill audits and competitive pressure on hourly rates, law firms that enjoyed long-standing relationships with insurance clients are being threatened with the loss of business to competing firms. As a result, law firms specializing in insurance defense are feeling a profit squeeze that is, perhaps, greater than any other sector of private legal practice. This squeeze, together with the fear of losing a line of insurance defense work entirely as insurance companies consolidate, causes many firms to reconsider their identity and the manner in which they approach the legal marketplace.

The Insurance Defense Law Firm
It could be argued that almost all litigation involves insurance. But, in common usage, insurance defense involves defense work managed and paid for by an insurance company and coming through a relationship with an insurance company that includes an agreement for discounted fees. A precise definition of insurance defense practice is unnecessary, however, because what is at issue is the work performed for insurance companies at rates sometimes as much as 50 percent below the prevailing hourly fee for non-insurance company clients. It should be noted that not all insurance defense work is subject to the most competitive rate pressures. Certainly sophisticated coverage and bad faith litigation can be at relatively high hourly rates.

Firms that primarily perform insurance defense work seem to have certain unique cultural characteristics. While they may differ among firms, most share several specific characteristics that may be difficult for these firms to admit, little less change:

1. High satisfaction. Almost uniformly, partners in largely insurance defense firms seem to possess a high level of job satisfaction and satisfaction with their firm. Indeed, for the litigator who wants to spend his life in the courtroom there is probably no better practice (other than, perhaps, criminal law) than insurance defense. Appropriately, insurance defense lawyers take great pride in their number of trials to verdict, differentiating themselves as trial lawyers compared to litigators who may rarely appear in court other than to argue motions. As one partner put it, “Being a lawyer is a vocation, being a trial lawyer is a calling.”

2. Poor client service ethic. Many lawyers whose careers have been largely devoted to insurance defense work have a difficult time serving commercial clients. While the insured may technically be the client the lawyer is defending, it is the claims adjuster who selects counsel, calls the shots and pays the bills. Claims adjusters make judgments on outside counsels’ performance based on the law firm’s hourly rates, the format of their bills and the outcome of their cases. There is little value placed on the bedside manner so important with clients in normal commercial matters. As a result, with insurance clients, the basics of client service can often be ignored. Many insurance defense trial lawyers seem to have difficulty appreciating the importance to clients of promptly returned phone calls, keeping the client informed and presenting bills that not only document charges but demonstrate accomplishment.

3. Lack of teamwork. Insurance companies decry what they view as duplicate lawyering. As a result, a classic insurance defense firm takes pride in lean staffing of cases, citing the Texas Ranger motto: one riot, one ranger. Insurance defense lawyers often describe themselves and act as lone wolves. In the extreme they will have their own cadre of young partners, associates and paralegals working exclusively on their clients’ cases.

4. High value placed on working attorney production. Firms with an insurance defense background tend to place a high value on the amount of effort put forth by an individual attorney. Often the primary (if not sole) criterion for partner compensation is the number of billable hours worked or working attorney dollars collected with relatively little credit given for business produced or non-billable activities. This also bolsters the lack of teamwork because there is no compensation incentive for giving work to someone else that a lawyer could do himself.

5. Lack of business development skills. In firms with deep insurance defense roots, young lawyers have often been historically discouraged from attempting to attract new business. Emphasis instead was placed on enhancing trial skills. The result is that insurance defense firms have an abundance of trial lawyers who have neither the skills nor the interest in attempting to develop non-insurance work.

6. Low associate-to-partner ratios. If lawyers are judged by their personal production of billable time, then it is appropriate that the standards for partnership would be based on quality as a trial lawyer, history of high hour production and a given number of years of laboring in the vineyards. With this relatively liberal screen and, often, a relatively small differentiation between partner and associate billing rates, it is not surprising that there is little incentive to not promote an associate in an insurance defense firm.

7. Low hourly rates. Firms with a mixture of practices often charge lower than market rates for non-insurance defense matters. Years of having their rates attacked by insurance clients causes exceptional rate sensitivity in insurance defense firms and some insecurity about a lawyer’s value in the marketplace.

The Profit Squeeze
To attract business in competitive insurance markets, many underwriters have become highly aggressive in setting premium rates. To offset reduced profits, many insurance company claims managers are being pressured to reduce costs, particularly expenses for outside counsel. Firms dependent on an annual flow of cases from an insurance company find it necessary to accept low rates, limitations on cost reimbursements, increasingly onerous billing requirements and second-guessing from third-party bill auditors. Worse, no matter what the rate charged, there always seems to be an attorney down the street that will do it for five dollars less per hour.

Compounding the problem is the fact that insurance defense law firms are faced with the same costs as non-insurance firms. Regardless of practice, law firms pay essentially the same competitive salaries for support staff, even though the volume of cases in an insurance defense practice may necessitate greater secretarial support than a general practice. The costs of telephones, photocopies, library materials and similar office operating costs are basically identical in all law firms. Interestingly, despite the low rates, insurance defense firms typically spend as much or more in entertaining claims managers than do their non-insurance counterparts with traditional clients.

Traditionally, the two areas of cost savings for insurance defense firms have been the salaries paid to associates and occupancy costs. Theoretically, insurance firms could pay associates lower salaries because it was assumed that an insurance practice did not require the intellectual elite demanded by corporate general counsel. The reality is that insurance defense is an intellectually demanding practice requiring substantial trial skills. At the same time, many firms, either by tradition or in an attempt to dilute the financial impact of insurance billing rates, maintain substantial non-insurance defense litigation and business practices. To compete effectively for associates and retain their experienced associates, these firms must pay competitive salaries. Unable to justify internal differences in salaries according to practice, associates doing insurance defense work end up being paid at the same levels as attorneys with other practices. Even firms limiting their practice to insurance defense find that the general inflation of associate salaries has required some level of competitive increases.

A cost advantage that many insurance defense firms enjoy is lower occupancy costs. Because they do not work with corporate clients that expect a prestigious standard of office space, insurance defense firms can take advantage of lower cost class B buildings that offer lower rental rates and are often closer to the courts.

Strategic Options
Plotting the future can be an exceptionally difficult task for insurance defense firms. Given the frequently high level of satisfaction among their lawyers, a common theme among them is often their desire to see things remain the same. They enjoy and are accustomed to their practice and the manner in which their firm operates. Yet, at the same time, they are concerned by the lack of growth of their income in recent years and, in some firms, are fearful of the dependence that has grown on the work of just a few insurance companies.

With an infinite number of variations, there are basically three strategies that an insurance defense firm can pursue to cope with their profit squeeze. The firm can seek to reduce and eventually eliminate its insurance defense practice by bringing in other forms of work. It could continue performing insurance defense work by attempting to cordon off the insurance work in a separate department or office as an affiliated company. Finally, a firm could use technology and carefully developed practice procedures to make insurance defense work highly profitable.

Strategy 1. Change the Practice
Many insurance defense firms have developed some form of strategy involving the development of new practice areas. The hope is that by capping the amount of insurance defense work performed and growing the firm with new work, they will eventually reduce their dependence on insurance. This is a rational and realistic strategy provided that the firm has the ability to attract new non-insurance defense work and to manage the current level of insurance work.

Attracting new work occurs through the business development efforts of existing firm attorneys, or through the acquisition of laterals that have non-insurance defense business. These actions may sound easy. Our firm has a great reputation. We have some of the best standup trial lawyers in the state. Getting commercial litigation should not be hard and laterals should be beating a path to our door. But the firm’s reputation is as an insurance defense firm. In today’s legal world, law firms are often judged by how high their billing rates are and how much money their partners earn. Insurance defense firms do not rank highly on either of these criteria. At issue is why a client should take a risk in giving a complex commercial case to a firm with the reputation of doing insurance defense work. Case in point is the firms to which insurance companies give their major coverage issues, bad faith claims or large exposure cases. Odds are it is not the firms to which they give their routine claims defense work. Firms that cannot convince their largest clients of their capabilities beyond insurance defense will have a hard time convincing prospective clients. Telling the marketplace that the firm has great lawyers won’t do it — every good-sized law firm has great lawyers. Attempting to compete on price only enhances its insurance defense reputation.

It is, however, possible to change a practice and a reputation. Indeed, several AmLaw 100 firms have historically been dependent on insurance defense work. Typically change occurs in one or a combination of three ways:

i) Dilution. Some firms merge or acquire themselves out of insurance defense. This essentially involves constantly seeking mergers or group lateral acquisitions that do not involve insurance defense work. As the firm grows in new areas of practice, the firm is exposed to clients who may not have known the insurance defense reputation. At the same time, by bolstering credible practices in other areas, the insurance defense image is blurred and less dominant in peoples minds. Typically, such a strategy requires a long period of time, both to obtain the practice growth to dilute the insurance defense reputation and because it takes time for the legal market’s perceptions to change.
The process of change can be accelerated if the firm is acquired by a larger firm or participates in a merger of equals, provided that their merger partner presents a completely different image to the marketplace. This was certainly the case for many mid-sized firms during the rapid law firm growth years of the middle and late 1980s. In fairness, it is a more difficult strategy today because the acquiring firms have become more sophisticated in their selection of merger partners.

ii) Large Case Opportunities. A second way that firms have migrated away from an insurance defense practice is their involvement in mass tort and other forms of litigation. Firms that have been successful in landing a large group of cases have been able to provide their insurance defense litigators with other forms of work. For some firms, it was asbestos and other toxic tort cases that gave them the higher rate volume (even though much of it was insured) to move away from their traditional practice. For other firms, particularly in the southwest, it was the failing savings and loan work in the late 1980s representing federal agencies (FSLIC, FDIC, RTC, et al). For still other firms, it was the opportunity to gain work as a national or regional coordinating counsel for product liability cases. Whatever the opportunity, some firms were able to use large volume cases to convert their practices.

iii) Defections. A third common route by which firms have moved away from an insurance emphasis has been by the defection of their insurance defense lawyers. Firms that maintained a mixed practice saw increasing profitability differences between its insurance defense work and other areas of practice. This often resulted in decreased earnings for insurance defense partners even though the firm might have been prospering. The barriers to entry in starting a new law firm are not great, particularly if a group of lawyers have the promise of business from their client insurance companies. While these departures may have been traumatic for everyone involved, in retrospect they were quite successful with the departing lawyers being able to operate more profitably with a lower overhead cost, and the remainder of the original firm being able to dramatically increase its average revenue per attorney literally overnight.
It is unlikely that any firm would or could strategically plot a wholesale change away from insurance defense using one of the above scenarios. For most firms, these were historic anomalies. But they do demonstrate that firms can change their image, operations and profitability.

Strategy 2: Establish an insurance defense subsidiary
It is extremely difficult for some law firms to maintain a mixture of insurance work with a traditional client practice. Attempting to operate side-by-side practices with dramatically different forms of practice and levels of profitability constrains both sides of the firm from achieving their objectives. The business lawyers, whose practices spin off commercial litigation, complain that the insurance defense litigators don’t provide the level of responsiveness that the business clients demand. They are concerned that the insurance defense reputation makes the firm appear less capable of performing complex transactional work. The insurance defense lawyers complain that the business lawyers don’t bill enough hours and are extravagant in their expenditure of firm funds for marketing.

A number of firms have responded to these concerns by splitting the firm along insurance defense lines. One way of doing this is to create a functional division within the law firm by creating an active and visible separation between the firm’s attorneys involved in insurance defense work and those in other practices. This often involves differentiated locations within their office space, offices on different floors of their building or even physically separated offices. Some firms attempt to operate differently to reflect the unique needs of each practice with separate recruitment programs, different pay scales for associates and different levels of office support. One firm went so far as to hire insurance associates as staff attorneys at starting salaries 40% below their partnership track counterparts, housed the staff associates in cubicles and provided only word-processing secretarial support.

The primary difficulty of attempting to operate a firm-within-a-firm is that it is contrary to the culture of most law firms. Whenever one attempts to create a subdivision within a social or business unit, some level of negative results will occur. This is particularly true when the basis of the division is that one practice is seen as being more profitable, sophisticated or intellectually demanding than the other. The most common deterioration results from commercial litigation partners borrowing insurance defense associates to work on their large cases and, eventually the line between the two sides of the firm became blurred once again.

The result is that, while a firm-within-a-firm has been tried on numerous occasions by law firms over the past 20 years, it simply does not work as a long term operating strategy.

A second form of organization is to create a subsidiary to perform all or certain lines of the firm’s insurance defense work. This involves creating a complete functional (and perhaps a legal separation) of the two operations. Some firms that have attempted a subsidiary approach have operated the law firm and the subsidiary under the same name but in separate locations and with separate managing partners and administrative staffing (although some use the primary law firm to provide contractual administrative services to the insurance defense operation). Others operate under a similar but somewhat different name (Whinter & George and Whinter Defense Counsel). The function of name and structure is determined by the degree to which the traditional law firm wishes to disassociate itself from the insurance defense practice and the importance of name familiarity in attracting continued insurance work to the subsidiary.

Operating a subsidiary of this type requires exceptional management. The portability of practices make the subsidiary vulnerable to defections if the insurance defense attorneys see the primary firm as siphoning off too much of the profits. By the same token, if the subsidiary does not produce sufficient profits, the primary firm must question why it is involved in having its capital and management resources involved rather than pursuing other practice opportunities.

Two common factors seem to be in place where firms have operated successful insurance defense subsidiaries. First, there must be a great separation of the two entities; separate offices, separate administration and very few visible ties. Second, the management of the insurance subsidiary must be an equity partner in the primary firm and must be the main liaison with the insurance clients.

A third means of separation is where the primary firm spins off the insurance defense practice with a formal referral relationship between the two firms. In such cases the primary firm eases the transition for the partners forming the insurance defense firm by providing technical and administrative support, operating capital and office space. The greatest advantage, however, is the primary firm’s public announcement of the spin off to the insurance industry, thereby providing greater confidence in the new entity. Firms that have used the spin off approach have experienced a very high level of client retention and great marketplace acceptance of the action.

Strategy 3: Reorganize as a specialized insurance defense firm
In most cases, firms view the insurance defense practice as being the less profitable stepchild and, therefore, consider it as the candidate for becoming a subsidiary or being spun off. However, some highly successful firms have embraced the insurance practice and made it exceptionally profitable by strategically positioning themselves in the marketplace and creating a practice, legal staffing and support services around the needs of insurance defense.

The core of this strategy involves 10 concepts, each tied to providing an exceptionally cost-effective service to the insurance industry and generating an exceptional profit for the firm’s owners. These are somewhat aspirational, but the greater the degree to which a firm adopts these concepts, the more profitable the practice.

i) Specialize. There are distinct differences between the way a business practice law firm and an insurance defense firm operate. There are further differences within insurance defense. Firms that specialize in medical malpractice operate differently and require different support than firms specializing in auto liability or legal malpractice. The degree to which a firm becomes specialized tremendously increases its potential for profitability.

ii) Hire Trial Attorneys. Recruit attorneys who want to be trial attorneys. Hire laterally from the prosecutors office, insurance companies and other insurance defense firms. Identify the traits that make a good insurance defense attorney and look for those attributes rather than law school and class rank.

iii) Eliminate Partnership Track. One of the keys to profitability is the ability to leverage work to less costly associates and paralegals. Increasingly, young attorneys today are ambivalent about becoming partners. Many prefer the security of a salary, especially if prestige issues can be handled. Consider corporate-style titles.

iv) Establish Discipline. Create a management structure with a senior trial attorney supervising junior trial attorneys and paralegals. The key is to make each attorney accountable to someone for their actions, ranging from trial tactics and settlement offers to getting time charges in on time and in conformance with insurance company requirements.

v) Establish Written Practice Protocols. Train paralegals to work up files with a minimum of attorney involvement. Minimize the number of hands that touch each file to avoid duplicate effort.

vi) Put One Partner In Charge of All Fee Agreements. In no business should the salesperson set price and credit terms as well as supervise operations. Have one partner who works with the insurance companies in negotiating rates and establishing billing formats. Give that partner flexibility to offer discounts based on volume.

vii) Design Billing Procedures Around the Client. It is a simple fact of life that people like to do business with firms that make their life easy. Work to understand what claims adjusters and bill auditors want and give it to them. Understand that on many routine cases, the cost and the manner in which information is presented is as valuable to your client as the defense offered or the outcome.

viii) Push for Alternative Billing. Look for ways to bill on a fixed fee basis. Always tie discounts to volume. Constantly push for fixed fees or, if fixed fees are not possible, on blended rates.

ix) Find Values to Add to the Relationship. Without the client asking for it, present them with an annual report of how many cases you handled, what the cost per case was and the statistical batting average for settlement or verdict.

x) Reward Partners on Profits. The incentive for partners should be to get additional business, handle that business as efficiently as possible and supervise the delivery of the services the client contracted to receive. The partners’ roles as working attorneys should primarily be on matters where the client wants a partner to try the case, and cases where the partner wants to be involved because he or she finds the file interesting and fun.

Conclusion
There are no easy answers to managing an insurance defense practice. However, if a firm can make clear-cut strategic and operational decisions, it can begin a transition that will not only make it more profitable in a highly competitive market, but can make the difference in whether or not the firm is able to survive.

The keys to success are simple. First, the firm must develop a true strategic plan that defines the marketplace position the firm wants to achieve. Second, secret strategies don’t work. Therefore, it is essential that the game plan is clearly and consistently communicated within the firm. Finally, the implementation must be planned with specific partners having the authority to make the plan work.

Not surprisingly, the actions that are the easiest to accomplish and require the least change or management effort have the least potential for success. But, in all likelihood, taking any action away from the status quo may, in itself, represent a significant strategic option for the firm.